AC341

Corporate Governance, Risk Management and

Financial Audit

MT: 2022
Dr Renuka Fernando
Rerum cognoscere causas
Learning outcomes
By the end of the course students should have acquired and be able to
demonstrate:
1. Knowledge and understanding of the theoretical basis of corporate
governance, of its principles and practical methodologies, and of how it is
evolving.
2. Knowledge and understanding of the legal, professional and social environment
of, and the main professional institutions involved in.
3. A critical understanding of the problems connected to internal controls, risk
management and corporate financial audit
4. Transferable presentational and group-working skills.
Structure

# Section Weeks
1 Corporate Governance Week 1 & 2
2 Internal Control Week 3
3 Risk Management Week 3, 5 & 7 * no teaching Week 4, reading
Week 6
4 Financial Audit Week 8, 9 & 10
Summative presentations Week 11
Delivery
• Delivery in-person over 11 weeks (no teaching Week 4 & 6)
• Two 1.5 hr sessions a week, combined lecture and activities
• Materials on Moodle post session

Team work
• Groups for (1) activities and (2) project assessment; set in Week 2
• Week 11 group presentations (ref: ‘Assessment, Group Project’)
Feedback
• Formative coursework (for feedback only)
• Students can submit one 750-word essay by the end of Week 4 on which they
will receive feedback by the end of Week 5 MT. Topic released in Week 2.
• Late submissions will not be graded. The grade for this formative essay will not
affect the overall assessment for the course.

• Discussions in seminar and office hours.

 Assessment
Summative Overall Requirements Due
grade (%)
Group Project 40% • Project topic released in Week 2; includes Executive report:
executive report and group presentation in Sunday December 4th
Week 11 (13:00 via Moodle)
• Groups of 5 students (max.); sign up excel
on Moodle Presentation: December
9th (Week 10 seminar)
Take-home 60% • Title will be released at the end of Week 11 Friday 16th December
assignment on Friday 9th December (13:00 London time, via
• Maximum 1,750 words, essay will be run Moodle)
through Turnitin plagiarism software
Readings
Core texts (available in library)
• Andersen (2019). The Routledge Companion to Strategic Risk Management
(Routledge Companions in Business, Management and Accounting).
• Power (2016). Riskwork: Essays on the Organizational Life of Risk
Management. Oxford University Press (available online through LSE library)
• Gray, Manson & Crawford (2019). The Audit Process: Principles, Practice and
Cases (Cengage 7th Edition) (library ref: Course Collection HF5667 G77).
• Power (1999). The Audit Society: Rituals of Verification. Oxford University
Press. (library reference: Course Collection HF5667 P88)
Approach and contact
• Contribute
• Be open about your learning style!
• Email: [email protected]
• Office hours: Fridays, 12:30 to 13:30 in MAR 3.12
Questions?
SECTION 1: CORPORATE
GOVERNANCE
Section 1
Corporate Governance
2. Introduction
Section 1: Corporate governance
1. Introduction
2. Regulation
3. UK Corporate Governance Code, EU & US regulation
4. Issues in corporate governance
1. Introduction, Corporate Governance
• What is corporate governance?
• Different views of company purpose.
What is corporate governance?
• Attempts to resolve collective actions problems among
corporate claim holders
• The system by which companies are directed and
controlled
• Good corporate governance provides incentives for
managers and directors to pursue objectives which are
in the interests of the company and its shareholders
• Governing is not the same as managing
(Garvey, 2016, Ch2 in RCtSRM, page 32)
OECD Definition
Corporate governance reflects:

“a set of relationships between a company’s management, its board, its

shareholders and other stakeholders. Corporate governance also
provides the structure through which the objectives of the company
are set, and the means of attaining those objectives and monitoring
performance are determined.” (page 11)

Organisation for Economic Co-operation and Development (2004). OECD Principles of Corporate
Governance.
Corporate governance code
“Companies do not exist in isolation. Successful and
sustainable businesses underpin our economy and society by
providing employment and creating prosperity. To succeed in
the long-term, directors and the companies they lead need
to build and maintain successful relationships with a wide
range of stakeholders. These relationships will be successful
and enduring if they are based on respect, trust and mutual
benefit. Accordingly, a company’s culture should promote
integrity and openness, value diversity and be responsive to
the views of shareholders and wider stakeholders.”
Elements of corporate governance

Corporate
Governance

Internal Risk Financial

Control Management audit
Where does ‘governance’ take place?

IIA Position Paper (2013). THE THREE LINES OF DEFENSE IN EFFECTIVE RISK MANAGEMENT AND CONTROL (p.2)
 I want to buy consulting services … but need to consider…

D C

Cash £ 10,000 Related party? Conflict of Interest?

Expense - Consulting £ 10,000

Threshold in Policies ? Tendering Overstated amount? Manipulation of

Process? expenses?

Services received? Fake vendor?

Risk of financial and/or reputational loss?

Adequate controls in place to mitigate risk or comply?
 Key debates in corporate governance
• The purpose of the corporation: primacy of shareholders vs other
stakeholders
• The role of corporate boards of directors
• The rights of shareholders
• Measurement of performance.

See Harvard Business Review article by Paine and Srinivasan

(2019)https://hbr.org/2019/10/a-guide-to-the-big-ideas-and-debates-in-corporate-
governance
Why do we need corporate governance?
It depends on our view of company purpose.
1. Introduction, Corporate Governance
• What is corporate governance?
• Different views of company purpose.
Two views of the company:
1. A legal fiction reflecting an underlying nexus of economic
relationships between shareholders and the managers; or
2. A real entity operating in society and affecting multiple
stakeholders.

• What do you think are the implications for corporate purpose of these
two different views?
• And what are the implications for corporate governance?
• What are the ethical implications?
Viewing a company as a legal fiction:
• Implies a principal-agent relationship between shareholders and
managers.
• Misaligned incentives may lead to principal-agent problems and
agency costs.

• Can you think of an example of a misaligned incentive?

• What problems might result for shareholders from this?
• What can shareholders do to mitigate such “agency costs”
Shareholder primacy
Milton Friedman’s view:
• "In a free-enterprise, private-property system, a corporate executive
is an employee of the owners of the business. He has direct
responsibility to his employers. That responsibility is to conduct the
business in accordance with their desires...the key point is that, in his
capacity as a corporate executive, the manager is the agent of the
individuals who own the corporation...and his primary responsibility
is to them."
"A Friedman Doctrine: The Social Responsibility of Business is to
Increase Its Profits". The New York Times, September 13, 1970.
Who are shareholders?
• Shareholders have a residual interest and have voting rights (but
multiple classes of shares may result in differential levels of control)
• Passive investors (e.g. index funds) may not be actively engaged in
monitoring and controlling the companies in which they are invested
although this is changing (but reliance on proxy advisors)
• Activist investors (hedge funds) are engaged - but may force short-
termism (evidence is as yet inconclusive)
What do shareholders want?
• Stewardship:
• Protection of assets
• Prevention of fraud
• Accountability
• Truthful and unbiased reporting of financial position and performance
• Assurance about the resilience of the company (is it a going concern?)
Shareholders face agency problems
Agency costs – not just a recent
phenomenon
1494: Bank owned by the Medici family became insolvent after
building up large debts due to a lack of financial controls

1995: A bank which collapsed with losses of £827 million from

fraudulent futures contracts a Singapore futures trader, Nick
Leeson, who signed off on his own accounts. The London
directors were subsequently disqualified, as being unfit to run a
company.

2001: directors used fraudulent accounting methods to push up

the stock price.

2001: Directors and executives fraudulently concealed large losses in

Enron's projects. A number were sentenced to prison
Recent examples of agency costs
An alternative view: the company as a
‘real entity’
Companies’ actions affect
different stakeholders
whose rights should be
protected.

These actions should be

subject to scrutiny and
the focus of good
governance, taking all
stakeholders interests
into account.
 Shifting concept of corporate purpose
• To generate wealth for shareholders? Or to pursue a purpose which benefits
stakeholders while generates wealth for shareholders?
• And how should we measure performance beyond financial profit?
US:
• Business Roundtable’s new statement on corporate purpose issued in August 2019
highlighted corporate commitment to stakeholders as well as shareholders.
https://hbr.org/2019/08/181-top-ceos-have-realized-companies-need-a-purpose-beyond-profit

UK:
• Corporate Governance Code 2018 asks directors to state the company’s purpose,
values, and strategy.
• Purposeful company taskforce (2015): “Profit is not the purpose of a company -
profit is one outcome of identifying and pursuing a purpose that benefits society”
http://www.biginnovationcentre-purposeful-company.com/
Business Roundtable statement

Jamie Dimon, Chairman of Business Roundtable (and Chairman and

CEO of JPMorgan Chase):
“The American dream is alive, but fraying….Major employers are
investing in their workers and communities because they know it is
the only way to be successful over the long term. These modernized
principles reflect the business community’s unwavering
commitment to continue to push for an economy that serves all
Americans.”
Roundtable statement on stakeholders
We commit to:
• Delivering value to our customers.
• Investing in our employees. This starts with compensating them fairly and providing important
benefits. It also includes supporting them through training and education that help develop new skills
for a rapidly changing world. We foster diversity and inclusion, dignity and respect.
• Dealing fairly and ethically with our suppliers.
• Supporting the communities in which we work. We respect the people in our communities and protect
the environment by embracing sustainable practices across our businesses.
• Generating long-term value for shareholders, who provide the capital that allows companies to invest,
grow and innovate. We are committed to transparency and effective engagement with shareholders.
Each of our stakeholders is essential. We commit to deliver value to all of them, for the
future success of our companies, our communities and our country.
Questions about the roundtable
statement:

• Which stakeholders are missing?

• How should companies rank the different needs and preferences of
different stakeholders?
• Does current evidence support the assertions made in the statement?
• Who is responsible for “social policy”: government or corporations?
 Letter to shareholders from Jeff Bezos
(2018)
• As I said in the first shareholder letter more than 20 years ago, our focus is on hiring
and retaining versatile and talented employees who can think like owners. Achieving
that requires investing in our employees, and, as with so many other things at
Amazon, we use not just analysis but also intuition and heart to find our way forward.
• Last year, we raised our minimum wage to $15-an-hour for all full-time, part-time,
temporary, and seasonal employees across the U.S. This wage hike benefitted more
than 250,000 Amazon employees, as well as over 100,000 seasonal employees who
worked at Amazon sites across the country last holiday. We strongly believe that this
will benefit our business as we invest in our employees. But that is not what drove the
decision. We had always offered competitive wages. But we decided it was time to
lead – to offer wages that went beyond competitive. We did it because it seemed like
the right thing to do.
https://blog.aboutamazon.com/company-news/2018-letter-to-shareholders
Stakeholder view
Organizations:
• Create externalities for which they
should be held accountable
• Affect different groups in society
• Have a responsibility to a variety of
stakeholders - not just to
shareholders

Who are stakeholders? No common

consensus (Miles, 2012)
 What have we covered?
• Introduction to corporate governance:
• What is corporate governance?
• Why do we need it? (Different views of company purpose).

In the next section, we will consider the regulation of corporate

governance.
Section 1
Corporate Governance
2. Regulation
Section 1: Corporate governance

1. Introduction
2. Regulation
3. UK Corporate Governance Code, EU & US regulation
4. Issues in corporate governance

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2. UK regulation on corporate governance

• Companies Act 2006, corporate governance code and

other guidelines (directors’ duties, disclosure
requirements, and audit)
• Other governance regulation in the UK
• What’s new in the 2018 CG Code

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 Legislation

• Companies Act 2006:

• Directors’ duties S172
• Strategic Report S414
• External audit S475
• Directors’ remuneration S430

• Also:
• Companies Act 2006 (Strategic Report and Directors’ Report) Regulations 2013
(‘the 2013 Regulations’) requires quoted companies to report information on
greenhouse gas (GHG) emissions in their Directors’ Reports.
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Companies Act (2006)
 CA 2006 - Directors’ duties S172
• Duty to promote the success of the company
• S172 (1)A director of a company must act in the way he considers, in good faith,
would be most likely to promote the success of the company for the benefit of its
members as a whole and in doing so have regard (amongst other matters) to:
(a) the likely consequences of any decision in the long term,
(b) the interests of the company's employees,
(c) the need to foster the company's business relationships with suppliers, customers and others,
(d) the impact of the company's operations on the community and the environment,
(e) the desirability of the company maintaining a reputation for high standards of business
conduct, and
(f) the need to act fairly as between members of the company.

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CA 2006 - Strategic report disclosures
S414
• The strategic report is intended to enable shareholders to assess how the
directors have performed their duty under section 172 (duty to promote
the success of the company).
• UK AIM and many private companies must include (or note absence of)
disclosures of:
• KPIs, environmental and employee matters
• Principal risks and uncertainties facing the company.
• Quoted companies must additionally disclose:
• Environmental impact and social, community and human rights issues
• Gender analysis of directors, senior managers and employees
• a “section 172(1) statement” stating how the directors have had regard to the
matters set out in section 172(1)(a) to (f) when performing their duty under section
172.
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BEIS 2017 corporate governance reforms

• Section 172 Directors’ duties

• Executive pay
• Corporate governance arrangements
of large privately-held businesses

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BEIS 2017 corporate governance reforms
relating to directors’ duties
Large companies (within the meaning under the Companies Act 2006) will need to include:
• A separately identifiable statement in the strategic report describing how the directors
have complied with their duty to promote the success of the company having regard to
the matters section 172(1)(a) to (f) of the Companies Act 2006.
• A statement in the Directors’ Report summarising how the directors have had regard to
the need to foster the company’s business relationships with suppliers, customers and
others, and the effect of that regard, including on the principal decisions taken by the
company during the financial year.
• All UK registered companies with more than 250 employees will have to include a
statement in the Directors’ Report summarising how their directors have engaged with
employees, how they have had regard to employee interests, and the effect of that
regard, including on the principal decisions taken by the company during the financial
year.
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BEIS 2017 corporate governance reforms:
Executive pay
Directors’ Remuneration Report (2019)
• Companies which are quoted or with more than 250 employees must
publish the ratio of their chief executive officer’s 'single figure' total
remuneration to the median, 25th and 75th percentile total
remuneration of their full-time equivalent UK employees in their
directors’ remuneration report.
• Companies will need to explain the reasons for changes to the ratio
year on year and also whether the company believes the median ratio
is consistent with the company’s wider policies on employee pay,
reward and progression.

00
 Remuneration disclosure for listed
companies (2018)
The Companies (Miscellaneous Reporting) Regulations 2018 make changes to
reporting of directors’ remuneration for quoted companies:
• More than 250 employees are required to publish the ratio of their CEO’s ‘single
figure’ total remuneration to the median, 25th and 75th percentile total remuneration
of their full-time equivalent UK employees in their directors’ remuneration report.
The ratios will be calculated on a group-wide basis by reference to UK employees
only.
• Annual Statement from the Remuneration Committee Chair will need to provide a
summary of any discretion used.
• The notes to the single-figure in the Annual Report on Remuneration will need to
provide additional guidance on the impact of share price movements on the
outcomes, and detail on whether discretion has been exercised to reflect share price
movements.
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Corporate governance arrangements
of large privately-held businesses
Requires all companies of a
significant size, that are not
currently required to provide a
corporate governance
statement to disclosure their
corporate governance
arrangements
Corporate Governance Code (2018)
Corporate Governance Code
(2018)
Addresses the following areas:

• Board leadership and company purpose

• Division of responsibilities (on the board)
• Composition, succession and evaluation (of the board)
• Audit, risk and internal control
• Remuneration

00
FRC Principles for the governance of
private companies (2018)
• Private companies benefit from limited liability
status and do not obtain funding from the public
markets but they have not been subject to the
same reporting and accountability requirements
as public companies.
• The Wates Principles do not set out detailed
provisions, but offer guidance to assist companies
in explaining their approach to applying principles
on a “comply and explain” basis. (Contrast this
with listed companies who need to report on a
‘comply or explain’ regarding the CGC .

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 Statutory reporting for private companies
Companies (Miscellaneous Reporting) Regulations 2018

• UK registered companies with either 2,000 or more global employees

or a turnover over £200 million globally and a balance sheet over £2
billion globally will be required to include a statement as part of their
Directors’ Report stating which corporate governance code, if any, has
been applied and how.
• The Companies (Miscellaneous Reporting) Regulations 2018:
• The directors’ report must include a statement of:
• which corporate governance code, if any, the company applied in the financial year
• how the company applied this corporate governance code, and
• how the company departed from this code (if it did) and its reasons for doing so.
00
“Consideration “Effective boards ensure
should be given to that the company
separating the roles operates with a clear
of the chair and chief sense of purpose and
executive to ensure a collective vision. To
balance of power and promote this, boards will
effective decision- appreciate the
making.” importance of dialogue
with the workforce and
“The board should wider stakeholders
establish an around the company’s
internal control stated purpose and be
framework with proactive in ensuring that
clearly defined it takes place.”
roles and
responsibilities for
those involved.”

https://www.frc.org.uk/getattachment/31dfb844-6d4b-4093-9bfe-19cee2c29cda/Wates-Corporate-Governance-Principles-for-LPC-Dec-2018.pdf
Reference Grant Thornton
UK regulation on corporate governance

• Companies Act 2006, corporate governance code and

other guidelines (directors’ duties, disclosure
requirements, and audit)
• Evolution of governance regulation in the UK
• What’s new in the 2018 CG Code

00
Corporate governance timeline
• 1992 Cadbury (1992): CG is ‘the system by which companies are directed and
controlled. Boards of directors are responsible for the governance of their
companies. The shareholders’ role in governance is to appoint the directors and
the auditors and to satisfy themselves that an appropriate governance structure is
in place.’
• 1995 Greenbury Report on remuneration of directors
• 1998 Hampel Report – Combined Code (updated regularly to 2018)
• 1999 Turnbull Guidance on Internal Controls
• 2003 Revised Combined Code incorporating:
• Independent Review of non-executive directors (Higgs Report)
• Smith Report on Audit Committees (updated to 2016)
• 2009 Walker Report (corporate governance for financial institutions)
• 2010 UK Corporate Governance Code (renaming of Combined Code)
00
Corporate governance timeline
• 2011 Women on Boards (Davies Report) and FRC Guidance on Board
Effectiveness
• 2012 UK Stewardship Code (following Walker Report) and UKCGC
updated to incorporate diversity and diversity disclosures
• 2014 FRC Risk Guidance
• 2016 Hampton-Alexander Review (target for women on boards by
2020)
• 2018 New style CGC with revised guidance on board effectiveness
• 2018 Wates Principles for large private companies

00
UK regulation on corporate governance

• Companies Act 2006, corporate governance code and

other guidelines (directors’ duties, disclosure
requirements, and audit)
• Other governance regulation in the UK
• What’s new in the 2018 CG Code

00
What’s new?
Significant emphasis on the need for company culture and wider
stakeholder (including workforce) interests to be evaluated by the
board as key drivers of long-term company sustainability.

What does this mean for shareholder importance?

What do you understand by “culture”?

00
Was the new focus effective?
FRC review of reporting, Nov 2020

• Identified inconsistent reporting

• Corporate governance reporting failed to live up to stakeholder
expectations
• “Some companies continue to treat the Code as a box-ticking
exercise…” (formulaic reporting and failure to explain fully when they
do not comply with the Code provisions).
• “Many companies stated the importance of diversity at board level
and in the succession pipeline but offered little explanation to set out
what they are doing to deliver that.”
https://www.frc.org.uk/news/november-2020/reporting-on-the-new-corporate-governance-code-is

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Summary - UK regulatory environment
• Companies Act 2006 (directors’ duties, disclosure requirements, and audit)
• Large and Medium-sized Companies and Groups (Accounts and Reports)
Regulations 2008
• Directors’ remuneration disclosures
• NB BEIS corporate governance reforms effective from 2019
• UK Corporate Governance Code
• Other regulation (not covered in this course):
• Stewardship Code to encourage institutional investors to engage in corporate
governance in the interests of their beneficiaries (the shareholders).
• UK Listing Rules and Disclosure/Transparency Rules (not discussed in this course)

00
What have we covered?
The regulatory landscape for corporate governance in the UK

Next section:
• UK Corporate governance code
• European Regulation
• US regulation and comparisons with the UK

00
Section 1: Corporate Governance
1. Introduction
2. Regulation
3. UK Corporate Governance Code, EU & US regulation
4. Issues in corporate governance
Section 1
Corporate Governance
3. UK Corporate Governance Code, EU &
US regulation
3. UK Corporate Governance Code, EU & US
regulation
• UK Corporate governance code
• European regulation
• US regulation
3. UK Corporate Governance Code, EU
& US regulation
• UK Corporate governance code
• European regulation
• US regulation
Introduction to the regulators

The regulation of corporate governance

• UK

• Europe

• US
Corporate Governance Code (2018)
Addresses the following areas:

• Board leadership and company purpose

• Division of responsibilities (on the board)
• Composition, succession and evaluation (of the board)
• Audit, risk and internal control
• Remuneration
 Corporate Governance Code 2018
• Collective responsibility within a unitary board
• The application of principles on a ‘comply or explain’ basis
• UK Listing Rules require companies to state how they have applied the
Principles.
• Investors to act when a company fails to comply (UK Stewardship
Code)
• Greater emphasis on stakeholders than in the original Cadbury Report:
“Successful and sustainable businesses underpin our economy and society by
providing employment and creating prosperity….To succeed in the long-term,
directors and the companies they lead need to build and maintain successful
relationships with a wide range of stakeholders.” (p1, CGC 2018)
Corporate Governance Code (2018)
Addresses the following areas:

• Board leadership and company purpose

• Division of responsibilities (on the board)
• Composition, succession and evaluation (of the board)
• Audit, risk and internal control
• Remuneration
Leadership and company purpose
 Leadership and purpose – some key
provisions
• The board should assess the basis on which the company generates and preserves
value over the long-term.
• The board should assess and monitor culture.
• In addition to formal general meetings, the chair should seek regular engagement
with major shareholders in order to understand their views on governance and
performance against the strategy.
• The board should understand the views of the company’s other key stakeholders
and describe in the annual report how their interests and the matters set out in
section 172 of the Companies Act 2006 have been considered in board discussions
and decision-making.
• There should be a means for the workforce to raise concerns in confidence and – if
they wish – anonymously.
Leadership and purpose – some key
provisions
• When 20 per cent or more of votes disagree with a resolution, the
company should explain, when announcing voting results, what
actions it intends to take to consult shareholders in order to
understand the reasons behind the result.
• An update on the views received from shareholders and actions taken
should be published no later than six months after the shareholder
meeting.

Why do you think these requirements are included?

Corporate Governance Code (2018)
Addresses the following areas:

• Board leadership and company purpose

• Division of responsibilities (on the board)
• Composition, succession and evaluation (of the board)
• Audit, risk and internal control
• Remuneration
Division of responsibilities
Division of responsibilities – some key
provisions
• Independence of board members
• At least half the board, excluding the chair, should be non-executive
directors whom the board considers to be independent.
• Non-executive directors have a prime role in appointing and removing
executive directors. Non-executive directors should scrutinise and
hold to account the performance of management and individual
executive directors against agreed performance objectives.
Corporate Governance Code (2018)
Addresses the following areas:

• Board leadership and company purpose

• Division of responsibilities (on the board)
• Composition, succession and evaluation (of the board)
• Audit, risk and internal control
• Remuneration
Composition, succession & evaluation
 Composition, succession & evaluation –
some key provisions
• The board should establish a nomination committee to lead the process for appointments. A
majority of members of the committee should be independent non-executive directors.
• All directors should be subject to annual re-election.
• The chair should not remain in post beyond nine years from the date of their first appointment to
the board.
• There should be a formal and rigorous annual evaluation of the performance of the board, its
committees, the chair and individual directors … In FTSE 350 companies this should happen at least
every three years. The external evaluator should be identified in the annual report and a statement
made about any other connection it has with the company or individual directors.
• The annual report should describe the work of the nomination committee, including:
• the policy on diversity and inclusion,
• the gender balance of those in the senior management and their direct reports.
 Compliance with the 2016 CG code

https://www.frc.org.uk/getattachment/53799a2d-824e-4e15-9325-33eb6a30f063/Annual-Review-of-the-UK-Corporate-Governance-Code,-Jan-2020_Final-
Corrected.pdf
Corporate Governance Code (2018)
Addresses the following areas:

• Board leadership and company purpose

• Division of responsibilities (on the board)
• Composition, succession and evaluation (of the board)
• Audit, risk and internal control
• Remuneration
 Audit, Risk and Internal Control

AC comprises at least 3 independent non-executive (excluding chair) and:

• at least one of AC has recent and relevant financial experience.
• AC as a whole shall competent in the sector in which the company operates
 Audit, risk and control: key provisions
• Responsibilities of the AC:
• monitoring the integrity of the financial statements of the company e.g. whether they are fair,
balanced and understandable, and provide the necessary information necessary for shareholders
to assess the company’s position and performance, business model and strategy;
• reviewing the company’s internal control and risk management systems, unless done by a separate
board risk committee composed of independent non-executive directors, or by the board itself;
• monitoring and reviewing the effectiveness of the company’s internal audit function
• conducting the tender process and making recommendations to the board, about the
appointment, reappointment and removal of the external auditor, and approving the
remuneration and terms of engagement of the external auditor;
• reviewing and monitoring the external auditor’s independence and objectivity;
• reviewing the effectiveness of the external audit process, taking into consideration relevant UK
professional and regulatory requirements;
• developing and implementing policy on non-audit services and considering the impact this may
have on independence.
Audit, risk and control: reporting
The annual report should describe the work of the AC, including:
• How any significant issues relating to the financial statements were addressed
• How it assessed the independence and effectiveness of the external audit process;
• If the board rejects the AC’s recommendation on auditor appointment or removal,
provide an explanation
• Where there is no internal audit function, how internal assurance is achieved, and
effects on external audit;
• How auditor independence and objectivity are safeguarded, if the external auditor
provides non-audit services.
 Audit, risk and control: reporting
• The annual report should state the directors’ responsibility for preparing the annual report and accounts, and that
they consider the annual report and accounts, taken as a whole, is fair, balanced and understandable, and
provides the information necessary for shareholders to assess the company’s position, performance, business
model and strategy
• The board should carry out and report a robust assessment of the company’s emerging and principal risks -
describing the principal risks, procedures and mitigation approaches.
• The board should monitor the company’s risk management and internal control systems and, at least annually,
carry out a review of their effectiveness and report on that review in the annual report. The monitoring and review
should cover all material controls, including financial, operational and compliance controls
• In annual and half-yearly financial statements, the board should state whether it considers it appropriate to adopt
the going concern basis of accounting, and identify any material uncertainties to the company’s ability to continue
to do so over a period of at least twelve months from the date of approval of the financial statements.
• Taking account of the company’s current position and principal risks, the board should explain in the annual report
how it has assessed the prospects of the company, over what period it has done so and why it considers that
period to be appropriate.
Marks and Spencer
2021
Marks and Spencer 2021 (key risk)
FRC Financial Reporting Lab on risk
reporting
“Since the financial crisis there has been an increased focus on risk
management; in response, the reporting of principal risks has become
more comprehensive…there have also been calls for directors to
demonstrate further how they have promoted the success of a
company and in doing so how its business model remains relevant
and sustainable. …Investors highlight the information around the risk
assessment process as one area of disclosure that helps them to
understand better why the company is comfortable with the principal
risks disclosed.”
FRC Financial Reporting Lab on risk
reporting
FRC Financial Reporting Lab on risk
reporting – what investors want to see
Corporate Governance Code (2018)
Addresses the following areas:

• Board leadership and company purpose

• Division of responsibilities (on the board)
• Composition, succession and evaluation (of the board)
• Audit, risk and internal control
• Remuneration
Remuneration
Reference M&S
… but is it perfect?
• Over 600 responses from
consultation
• Key outcomes include:
• new regulator, the Audit, Reporting
and Governance Authority (ARGA)
on public interest
• public interest in large private
companies
• making large companies’ reporting
more useful, risks and assured
Exercise
Compare M&S and Grant Thornton (see required readings)

• What are the key differences in statements?

• What do you think accounts for these differences?
• What could be improved? And how?
3. UK Corporate Governance Code, EU
& US regulation
• Corporate governance code
• European regulation
• US regulation
 The regulation of corporate governance
• Corporate governance. EC Directive 2006/46/EC: all listed companies to produce a corporate governance statement in their annual report to shareholders.

• European Commission Directive 2006/46/EC requires all listed companies to

produce a corporate governance statement in their annual report to
shareholders.
• Diversity of board structures across the EU: unitary, two-tiered, and Nordic
boards
• Trends include:
• an increased focus on board diversity, and many European countries have
introduced gender quotas Directors’ duties in many countries have been
clarified,
• an increased scrutiny concerning related-party transactions; and
• Board evaluations are becoming increasingly common.
3. UK Corporate Governance Code, EU
& US regulation
• Corporate governance code
• European regulation
• US regulation
 US corporate governance
• State corporate laws (Delaware General Corporation Law (DGCL):
• The formation corporations, rights of shareholders, rights and duties of directors,
• Model Business Corporation Act, a model set of laws prepared by the American Bar
Association.
• Shareholder suits are the primary enforcement mechanism of state corporate law.
• Federal regulation (SEC)
• The Securities Act (1933) re offerings/sales and Securities Exchange Act (1934) re disclosure
requirements.
• Sarbanes-Oxley Act (2002) – “The Public Accounting Reform and Investor Protection Act
• Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 for financial services.
• Stock exchange listing rules
• Corporate governance guidelines and codes of best practice including for example:
• American Law Institute (ALI) Principles of Corporate Governance
• National Association of Corporate Directors Key Agreed Principles
• Business Roundtable Principles of Corporate Governance
 US vs UK corporate governance
• No explicit US corporate governance code but state and federal law, listing
rules, specific regulations and best practice guidelines.
• The US has not adopted a corporate governance code for US companies
(CG covered by state and federal laws, regulations and listing rules).
• Shareholder primacy more dominant in the US. Officers and directors in the
United States do not owe any duty to employees of the corporation in
carrying out their managerial roles although some institutional
shareholders have advocated for a greater focus on corporate purpose and
ESG (e.g. Larry Fink of Blackrock with $6 trillion under management).

https://www.natlawreview.com/article/revisions-proposed-to-uk-corporate-governance-code-overview-and-comparison-aspects
UK vs US: Separation of CEO and chair
• Required in UK. Intended to allow CEO to focus on
operational/strategic issues and the chair to focus on oversight and
governance and mitigation of conflicts of interests re executive
compensation, succession planning and appointments.
• In the US, a recent trend has been towards separating the roles:
“53% of boards split the chair and CEO roles between two individuals, compared
with 50% last year. The trend toward separating the roles has been growing
steadily for more than a decade; 37% of boards divided the roles in 2009.”
(Spencer Stuart Board Index, page 22)
Rules vs principles
• UK – mostly a comply or explain basis of corporate governance –
thought of as more principles-based
• US – Sarbanes-Oxley is mandatory – considered to be rules based
Rules or principles?
“A rules-based market offers more confidence that corporate
governance principles have been complied with, whereas a principle-
based market does not offer this assurance. Those in favour of the
‘comply or explain’ approach would counter this by arguing that this
assurance is indeed offered by markets which operate a principle-based
approach (such as the UK and Germany) on the basis that explanation
of non-compliance can be equivalent to compliance. In addition,
rules-based systems are very expensive to administer, a cost which is
ultimately borne by the shareholder. However, the extent to which the
‘comply or explain’ system offers good governance depends on the
quality of the explanation.” (Devine and Shrives, 2017 - page 41)
Next week
• Issues in Corporate Governance
• Case – Wirecard